• Blog
  • 3 Min Read
  • May 19, 2023

Sustainable Finance Disclosures: Are You Ready?

The Sustainable Finance Disclosure Regulation (SFDR), governed by the European Union (EU), is a key component of the EU’s sustainable finance agenda and is designed to promote greater transparency and consistency in environmental, social, and governance (ESG) disclosures by financial market participants and advisers.  

The SFDR applies to financial market participants and financial advisers operating in the EU, including investment managers, pension funds, insurance companies, and banks. It requires parties to produce mandatory disclosures at both the product and entity levels – failure to comply can result in significant reputational damage. 

Financial products subject to SFDR include: 

  1. Undertakings for the Collective Investment in Transferable Securities (UCITS )
  2. Alternative Investment Funds (AIFs), including venture capital and private equity funds
  3. Pension Products
  4. Insurance-Based Investment Products (IBIPs)
  5. Individual Portfolio Management (discretionary mandates

The SFDR provides a framework for the disclosure of ESG information to help investors make informed investment decisions and promote sustainable investments. These disclosures have been passed at two  levels: 

  • Level 1 disclosures became applicable in March 2021 and require qualitative, entity-level disclosures on policies, as well as identifying principle adverse impacts (PAI) of investments and mitigating actions.  
  • Level 2 disclosures for fiscal year 2022 are required to be made by June 30, 2023. These disclosures require reporting on 18 specific mandatory PAIs related to invested assets. Examples of PAIs include the GHG emissions of investee companies (metric tons CO2 equivalent), the share of investments in companies active in the fossil fuel sector, the average ratio of female to male board members in investee companies, and more. 

SFDR requires financial market participants and financial products to disclose PAIs. The PAIs refer to the negative effects that companies or investments are having on the environment, society, and governance (ESG) aspects. The disclosure of principal adverse impacts aims to provide transparency and accountability about the real-world impact of investments.  

The PAI’s that financial market participants and financial products are required to report under SFDR include: 

  • Greenhouse gas emissions 
  • Carbon footprint 
  • Biodiversity loss 
  • Emissions to water  
  • Social and employee matters 

The disclosure of PAIs in Annex 1 to 5 should include an explanation of the methodology used to identify, assess, and prioritize the PAIs. It should also describe the actions taken to mitigate the reported principal adverse impacts and any relevant progress made in addressing these impacts. The disclosure of PAI’s is intended to provide investors and stakeholders with a clearer picture of the specific ESG risks and opportunities associated with investments. 

The calculations required for PAIs will depend on the specific indicator being reported and the methodology used to assess the negative impacts. Some of the required calculations are: 

  • Carbon emissions – Calculations based on Scope 1, 2, and 3 greenhouse gas emissions. 
  • Biodiversity loss – Share of investments in investee companies with sites/operations located in or near to biodiversity-sensitive areas where activities of those investee companies negatively affect those areas. 
  • Emissions to water – Tonnes of emissions to water generated by investee companies relative to amount invested. 
  • Social and employee mattersCalculations based on gender pay gap, average female to male board members, share of investments involved in violations or that fail to monitor compliance with United Nations Global Compact (UNGC) principles or Organisation of Economic Co-operation Development (OECD) guidelines, exposure to controversial weapons. 

At Clearwater, we are continuously monitoring the changing ESG regulatory reporting landscape, this includes the recent consultation by the European Supervisory Authorities (ESAs) proposing amendments to disclosures made under SFDR. 

If you are interested in learning more about Clearwater’s commitment to assist in your ESG regulatory reporting, we can help! Register to speak to an expert today to learn how.  

Related Resources